by Fred E. Foldvary, Senior Editor, 10 December 2012

Professor N. Gregory Mankiw of Harvard University initiated and hosts “The Pigou Club” of economists, journalists, and politicians who have favorably written about pollution levies as an efficient way to reduce emissions. Arthur Cecil Pigou was the economist who was the first to deeply analyze externalities (uncompensated effects on others) in his 1920 book The Economics of Welfare.

Pigou proposed a levy on negative external effects equal to the social cost, so that buyers and users pay the full social cost of products. The most common applications are tolls to prevent traffic congestion, parking meters that vary by time of day, and pollution levies.

The policy of charging those who create negative externalities is named Pigouvian, or Pigovian. Mankiw advocates higher gasoline taxes, but that would also tax those car owners with cars that run quite cleanly and are driven in roads that are not congested. The best Pigovian policy is to focus the charge on the negative element such as harmful emissions.

Tax the bad output, rather than the input. If a carbon tax is on the emissions, there is an incentive for inventors and entrepreneurs to minimize the toxic outputs. If a carbon tax is on the input, that incentive is gone.

Statist economists refer to a Pigovian tax as correcting a market failure, while free-market economists recognize that in a pure market economy, all activity is voluntary, and so there are no significant negative externalities in a pure market. Pollution invades others’ property, and such trespass would require compensation, which would prevent the external effect. Compensated effects internalize the costs.

Members of the Pigou Club include Al Gore, Alan Greenspan, Paul Volker, and Paul Krugman. Members range from conservative to statist liberal to green to libertarian. Essentially, any person who thinks clearly and objectively about externalities is going to be a Pigovian.

Environmentalists and economists have proposed a “green tax shift” to replace taxes on incomes and sales with taxes on environmental destruction. That would provide the double benefit of a greener environment and a more efficient economy.

Despite the Pigovian pollution charge being so obviously the optimal policy, the Obama administration has rejected it. An article in The New Yorker of 10 December 2012, “Paying for It” by Elizabeth Kolbert, describes Pigovian policy. It points out that global climate change is a planetary externality. Users of carbon-based fuels, especially coal and oil, are not paying the full cost of the energy. The cost is shifted to the victims of climate change, with ever worse storms and droughts and floods. The cost is also shifted to future generations who are unable to vote today.

To the extent that global warming has been caused by emissions, this is an environmental tax imposed on the human, animal, and plant world. Moreover, today’s massive pollution is unnecessary, because all economies could implement the green tax shift. The developing countries all have harmful taxes that could be replaced by Pigovian payments.

There seems to be not enough government revenue to pay for the billions of dollars needed to reduce pollution and protect against storms and rising seas, but when a disaster such as the New York City and New Jersey storms happened, funds arose to repair the $60 billion in damage.

Even oil companies have become Pigovian. It is therefore puzzling that President Obama has not come on board the Pigou train. He did not favor a tax on emissions as a candidate, and according to the New Yorker article, his spokesman Jay Carney stated, “We would never propose a carbon tax, and have no intention of proposing one.”

The executive branch of the U.S. government is insisting on higher taxes for the rich just because the money is there, and even though basic economics tells us that higher costs and lower profits will push ever more firms out of the country, and the firms remaining in the country will avoid brining their foreign earnings back home.

Levies on pollution are a tax in form, but in substance, they prevent a subsidy, since consumers are subsidized when they do not pay the full cost of their purchases. A tax on land value too is the prevention of the subsidy of rent generated by public goods. Therefore the best taxes are those that are not taxes in substance, but the avoidance of subsidies.

Thus the administration seeks on the one hand to tax the rich, and on the other to hand the rich a land-value and pollution subsidy. Evidently the administration prefers to regulate pollution, but regulations have done a poor job of preventing today’s massive environmental destruction, and regulations do not enable a green tax shift.

We should include A. C. Pigou to the pantheon of the ten great economists: Adam Smith, David Ricardo, Henry George, Alfred Marshall, Milton Friedman, Carl Menger, Ludwig von Mises, Friedrich Hayek, and James Buchanan. The 100th anniversary of his book in 2020 may spur some Pigovian action, but meanwhile we will suffer eight more years of global damage.

-- Fred Foldvary

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Copyright 2010 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.